Tuesday, November 25, 2008

'Liar's Poker' Author Sees Upside To Market Crash

When Michael Lewis looks back on the Wall Street he wrote about in his 1989 best-seller, Liar's Poker, the street looks positively quaint. At the time, it was shocking that an investment bank CEO made $3 million a year. The current crash is different — very different. Michael Lewis says he didn't appreciate its distinctions until he began doing research four or five months ago. "The size of the problem is massive," Lewis notes. "Not only did trillions — trillions — of dollars get lent to people who won't be able to repay them, but Wall Street at the same time created a market in side bets about whether these people would be able to repay their loans. And that market in side bets is tens of trillions of dollars." I don't think, going forward, you will see people working at a place called Goldman Sachs taking home $70 million or $80 million at the end of each year, which they have done in the past." Such earnings are unwarranted, Lewis says. "One of the madnesses of the last 25 years … has been the rewards we've bestowed on financiers," he says. "The people who have actually been allocating the capital on Wall Street have done a rather bad job of it. … The idea that these are essentially the highest-paying corporate jobs in America, by far, seems to me insane."

Those rewards have had "a really distorting effect" on society, Lewis says, creating a new norm for personal financial rewards for CEOs of all stripes. "That's going to be gone."

10 Comments:

Lewis is an engaging writer but his disdain for Wall Street seems to cloud his opinion. Morgan was villified as making obscene money while main street struggled. The charges have been directed at Wall Street CEOs ever since and I'm not sure what makes this time any different - the magnitude is keeping up with the times and in 5 years they will be making 'obscene' salaries again.

That's a good link to another Michael Lewis commentary, Mark . . . the more informative because he's a talented fellow who was making lots of money on Wall Street right after he graduated from Princeton, only to walk away from the job when he found the whole investment-strategy of his firm a form of flim-flam and start a writing career. At which, it goes without saying, he has been a well-deserved success.

1) The wider issue his comments deal with is the misuse of talent in American economic life, starting back in the 1980 go-go years --- which ended with the stock market crash of Black Monday in 1987, the junk-bond scandals, and the S&L collapse and subsequent government bailout.

Alas, no solid lessons learned from how many risks investment and savings banks --- not to forget brokerage firms and insurance firms --- were taking even in those days with their creditors' and investors' and depositors' funds.

Far from it,the go-go years of the 1990s that led to the crash of Long Term Capital Investment --- showing what would happen to unregulated hedge-funds --- and the wider dot.com crash did, alas, nothing to hammer home any more solid lessons.

Followed, of course, by the incredible explosion of derivatives, collateralized debt obligations (CDOs), lunatic credit default swaps (CDS or just CS) that went from $1 tillion in 2001 to over $60 trillion in 2007 --- all phantom-like insurance schemes that provided illusory insurance for ever more high-octane risks by financial institutions --- and the recent housing and financial meltdown.

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3) Which brings us back to the terrible misallocation of talent in this country caused by the explosion in financial innovations since the late 1970s --- largely unregulated --- and the interstellar incomes to the top management of our financial institutions.

Tersely put, the lures of quick, skyrocketing income led way too many gifted young men and women --- some just out of college, others with MBA's, law degrees, or Ph.D.'s --- to go into finance, for which they had no special training (as was the case with Lewis), and use their mental endowments for what in the end has proved catastrophic for our economy today . . . not to mention the disappearance of two investment banks and the need to salvage the three remaining ones, countless banks and insurance firms, and heaven knows what else.

4) Back in the 1980s, I noticed this when Rhodes Scholars no sooner finished their two or three year-stint at Oxford than they would be offered the equivalent of $300-400,000 in today's dollars as a starting salary!

Not a one of them, even those who studied economics, had the slightest training for finance, let alone anything other than good minds that could justify such an income.

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5) A final observation here.

The lures of finance at the high levels that drained talent away from the rest of the economy had materialized in Britain by 1900 too.

The aggressive, risk-taking entrepreneurial middle classes who had created the industrial revolution and made Britain the first fully industrial country by 1850 sent their sons and grand-sons to expensive, high-status "public schools" like Eton. There they learned to become proper gentlemen, respect hierarchy, and learn that the only respectable occupation for a "gentleman" to make money in --- assuming you didn't inherit a fortune and could lead a life of leisure --- was in banking and investment firms.

As a result --- one among many causes --- British industry badly lagged American and German industry in productivity by 1900 . . . to the alarm of the British government, which set up Royal Commissions to study the gaps (huge).

And despite some modernization and upgrading of British industry in the 1930s --- behind protective tariffs and the imperial system --- it has never fully kept pace with industrial and post-industrial innovations since then.

(Interesting related point: Japan, behind massive tariff barriers in the 1930s, also underwent a big moderizing shift in industry: by 1941, when it attacked the US and British in Asia, it had moved from small manufacturing firms to giant ones.)

" ... use their mental endowments for what in the end has proved catastrophic for our economy today"

Mental endowments?? If these people are as gifted as you claim, how did we wind up in this mess? I can't wait to see how their "gifts" pay off for society when they move to other professions. God spare us.

Lewis tells a great story and there is certainly a great deal of truth to what he says.

That being said Lewis has been predicting the end of Wall St. for some time. Wouldn't it be fair to describe this as a minority view while the majority of economists believe that the issues facing the global economy will eventually be resolved.

The usual Lewis comeback is that few economists predicted the present crisis. Predictions of the future are not known for high accuracy in any field.

Buggy Prof,

Interesting observations regarding Great Britain.

Hopefully, we will get a few more great minds working in engineering and medical technology.

"And despite some modernization and upgrading of British industry in the 1930s --- behind protective tariffs and the imperial system --- it has never fully kept pace with industrial and post-industrial innovations since then"...

I think it's more a matter of long-term interest. The money a CEO makes should be tied, not only to the short-term interest but the longer-term interest, too. And I'm talking 10-20 years down the road, not "next year".

Mechanisms for tying the financial rewards to the long-term health of the company should be a large chunk of the company's rewards.

I don't give a crap about someone making 30-40 million a year, if they are making the right choices.

It's ones getting bailed out right now who leave with a golden parachute kicking in that should get their incomes nullified. I'm sorry -- if you run a company into the ground, a golden parachute should be utterly nullified.

Problem with the 10-20 year time frame is the difficulty to administer. Agree that perks and golden parachutes are very inappropriate under the circ's. We are starting to finally see some executives waiving these perks which is as it should be.

Granted, there certainly has been excessive risk taking but there has also been a glut of cash in the global marketplace chasing a limited # of good investments. A bubble is not surprising.